Postings on books (mainly non-fiction), a few films and matters of interest by Lorenzo from Oz (aka Downunder)

Sunday, March 17, 2013

The problem with saying money is "tight" or "loose"

This is based on a comment I made here in response to a post which talks about recessions as monetary phenomenon (which I agree with). It is the terminology of money being "tight" or "loose" I have some problems with.

Money matters because, in a monetary exchange economy, almost all transactions are mediated by money. (Hence the demand for goods and services is the "supply" of money circulating in the economy.) So, everyone cares (at least to some extent) about their money income and the expected future swap values of (their) money. (In a monetary exchange economy, goods and services have prices, money has swap values; it keeps the terminology, and so thinking, clearer.) Something everyone in an economy cares about is going to matter a lot more than something only some folk care about.

If people have expectations that the money is going to significantly lose value, obviously they have an incentive to spend sooner rather than later. This will be an economy-wide tendency that will tend to drive up money incomes. If they think it is going to significantly gain value, clearly they have an incentive to spend later rather than sooner. This will be an economy-wide tendency that will tend to drive down money incomes.

If they expect it to retain value reasonably well, then it all turns on their future expectations about money income. If they have poor expectations, that creates an incentive to hold money. If those expectations are limited to a particular industry, then folk will tend to exit the industry and other industries will not have to bid quite so high for resources, stimulating them. If these expectations are general, then the tendency to hold money will tend to drive down money incomes. (Which comes back to something everyone cares about matters a lot more than something only some folk care about.)

The trouble with the "loose" and "tight" terminology is the two axes problem--do you mean that money will tend to lose/gain value, or do you mean that people have poor expectations of future income, or some combination of the two? Presumably "disastrously tight" means gain swap value plus poor income expectations. And sure, "ugly" deflation means that, but there is a certain amount of chicken-and-egg problem here since each will cause the other. So the two axes are not causally independent.

Worse, you can have serious supply issues for goods and services as well as money, so poor income expectations AND falling swap values. (We could call this case "Greece": I have limited sympathy for a country which is still paying lots of people to get in the way of folk transacting and then complains about a shortage of transactions.) So we cannot even say they are simply causally interdependent.